Insolvency - latest news from the courts and legislators

Murray Tingey, Partner and Daniel Vizor, Senior Associate | Thursday 25 October 2007

Amendments to Companies Act to come into force

The Ministry of Economic Development has announced that the amendments to the Companies Act will come into force on 1 November 2007, resulting in the long awaited introduction of the voluntary administration regime; new phoenix company provisions; significant amendments to the voidable transaction regime; and new liquidator reporting requirements.

Companies (Voluntary Administration) Regulations 2007

The Companies (Voluntary Administration) Regulations 2007 come into force on 1 November 2007. They prescribe the provisions that are deemed to be included in all deeds of company arrangements (unless specifically excluded) along with a form for the administrator's six-monthly report.

The introduction of voluntary administration will impact on those who deal with companies facing financial uncertainty, particularly financial institutions and secured creditors. Visit www.bellgully.com/resources/resource.01294.asp for further details on its likely effects.

Insolvency Act 2006 Regulations

Regulations are required under the Insolvency Act 2006 before it can be brought into force. These are currently being drafted and it is expected the Insolvency Act 2006 will come into effect sometime in December 2007.

Insolvency (Cross-Border) Act 2006

The Insolvency (Cross-Border) Act 2006 will not come into effect until Australia adopts the UNCITRAL Model Law on cross-border insolvency in its insolvency legislation. The Cross-Border Insolvency Bill 2007 (Aus) was introduced into Federal Parliament in Australia on 20 September 2007 and has received its second reading. It is not yet clear when this Bill will be passed.

Regulating Insolvency Practitioners

The introduction of voluntary administration has increased calls for a system to regulate insolvency practitioners. The insolvency law reforms which come into force on 1 November have been criticised for failing to deal with this issue.

The primary concern is that a small number of insolvency practitioners do not have the necessary integrity, knowledge and skills to be able to competently carry out corporate insolvencies, including voluntary administrations. A second discussion document has been released by the Ministry of Economic Development including three proposed options for regulating insolvency practitioners:

• strengthening the Companies Act 1993 by increasing the supervisory role of the Registrar of Companies, the remedies available to the court in the event of misconduct, and tightening reporting requirements for liquidators;

• introducing a voluntary accreditation regime; and

• introducing a mandatory licensing regime regulated by an independent body.

Strengthening the existing legislation

Some suggest that concerns about the competence of insolvency practitioners can be met by simply strengthening existing legislation. For example, the Companies Amendment Act extends the ability to ban a person from acting as liquidator. In making a prohibition order the court may now consider any previous breaches of duty by an insolvency practitioner, not simply those within the last five years as had previously been the case. It may also prohibit a person from acting as a liquidator for an indefinite period. The problem with these provisions is the cost and difficulty of obtaining an order when it is likely to be opposed. Parties dealing with a recalcitrant liquidator may not have the funds or patience required to obtain an order.

Further reforms include removing the provision allowing liquidators to escape their obligation to file reports if returns to unsecured creditors are unlikely to be more than 20 cents in the dollar and requiring liquidators to send a list of creditors to all creditors to assist them in organising themselves collectively.

Such measures are designed to increase the detection of breaches of duty and to strengthen the responses to them. However, these measures do nothing to ensure that only those with sufficient skill and knowledge are appointed to manage insolvencies in the first place, so that the risk of a breach occurring is minimised from the outset.

Voluntary accreditation

Under a voluntary accreditation scheme, an agency would be authorised to certify that individuals have acquired a sufficient level of skill and experience to conduct insolvencies. There is no prohibition stopping non-accredited individuals from practising, but they may not represent themselves as certified practitioners. Accredited individuals may be subject to the rules of the accrediting agency.

A voluntary scheme has some benefit in that it enables the public to determine whether an insolvency practitioner is likely to have sufficient competence to manage an insolvency. This will be of particular benefit to petitioning creditors with the right to appoint a liquidator. The scheme provides little benefit to creditors who cannot control who is appointed liquidator and who may face an insolvency administered by an incompetent, non-accredited insolvency practitioner.

Licensing

Under a licensing regime only licensed practitioners would be permitted to carry out insolvencies. The regime could take one of two forms. Like Australia, the regime could be overseen by a new, single licensing authority. Alternatively, a competitive licensing system could be introduced which would involve the establishment of an approval body which permits any number of bodies to compete with each other for the membership of insolvency practitioners. Membership to any one body would be compulsory to practice. The existing bodies most likely to participate in a competitive licensing scheme are the Institute of Chartered Accountants and the Law Society.

The main criticism of a licensing regime is that it will add to the cost of all insolvencies. The total cost of a new licensing scheme for insolvency practitioners could be considerable, especially given the relatively small number of insolvency practitioners in New Zealand. Ultimately these costs will be passed on to creditors. It is questionable whether these costs are outweighed by the benefits of regulation. Some of these costs could be minimised, however, through a competitive licensing scheme as the existing rules and disciplinary processes of bodies such as the Institute of Chartered Accountants and the Law Society could be used.

The Ministry has requested submissions on these proposals and arrangements for transferring from the current regime to the chosen regime. We would be happy to assist you draft formal submissions.

When is a transaction preferential?

The recent decision of the Court of Appeal in Levin v Market Square Trust represents an important development for determining whether a transaction is preferential in accordance with the Companies Act.

The facts

One Italy Limited (One Italy), the company in liquidation, leased business premises from Market Square Trust (Market Square). Market Square made demand for payment of rent arrears. One Italy failed to pay and advised that it had entered into an agreement to sell its business (the Agreement) to Peek Developments Limited (Peek). The Agreement was conditional on Market Square's consent to the assignment of the lease.

Market Square advised that it would consent to an assignment provided arrears were paid immediately. As a result, it was agreed between Peek and One Italy that Peek would pay the arrears to Market Square.

Following the liquidation of One Italy the liquidator served a notice on Market Square claiming the payment to Market Square by Peek was a voidable transaction by One Italy in terms of section 292 of the Companies Act.

Was the payment a "transaction" by One Italy?

The High Court declined to set aside the payment. The judge reasoned that the payment by Peek to Market Square was not money which it owed to One Italy under the Agreement because at the time of the payment the Agreement was not unconditional. The judge held that as One Italy never had any entitlement to the money paid it could never have been available in the pool of assets for distribution to other creditors.

The Court of Appeal decision

The Court of Appeal overturned the High Court's decision. It held that payment made to Market Square was made out of One Italy's money, pursuant to a separate loan agreement entered into by Peek and One Italy to enable the rent arrears owed to Market Square to be paid. This loan agreement provided that the sum lent would be "deducted from the purchase price for the business" on settlement but that "should the sale of the business to Peek not proceed for any reason, then those further monies will be refunded to Peek immediately".

Legal discussion

In its judgment the Court of Appeal held the only thing a liquidator must show is that the creditor received a greater payment than it would have otherwise received in the liquidation. Section 292 requires a comparison between the amount the creditor actually received from the company and the amount that the creditor would have received as part of the general body of creditors in the liquidation had the payment not been made. Overruling the decision of the High Court in National Bank of New Zealand v Coyle the court held that the section did not require the general body of creditors to be worse off as a result.

The court also upheld the decision in Porter Hire Ltd v Blanchett in which it held that the degree of any preference is to be measured against what creditors would receive in the actual liquidation. The court considered that the hypothetical liquidation concept would impose considerable practical difficulties on liquidators.

It was argued that this would unfairly mean that a creditor would be held accountable for events concerning the company after the transaction which the creditor had no control over. The court rejected this concern and held that:

"... the legislature has addressed that issue by defining the specified period prior to liquidation in which transactions of this kind may be voidable. And, in any event, considerations of fairness do not arise at this stage of the s292(2)(b) assessment. That assessment is purely objective. Considerations of fairness (using that concept loosely) arise later in the regime, when the court is considering what orders, if any, to make under s295 or whether to deny the liquidator recovery under s296(3). Under s296(3) the question of whether the creditor has notice of the insolvent state of the company will be directly relevant to determining whether the payment has been received in good faith."

Two key preference testers

The decision confirms two key points. First, that a liquidator need only show that a creditor has received a greater payment than it would have otherwise received in the liquidation. It is not a requirement of s292(2)(b) that the general body of creditors be worse off.

Secondly, the test for preference involves a comparison of what the creditor has received against what they are likely to have received in the actual, not hypothetical, liquidation of the company.

The importance of impartiality

The case of Esoon Limited v Grieve and Jollands and Annor and is a reminder to liquidators of the importance of being seen to be impartial when carrying out duties under the Companies Act 1993.

The facts

Williams Investment Group Ltd (Williams) had undertaken business with Esoon Ltd (Esoon) and when Williams failed to pay its invoices an adjudication under the Construction Contracts Act 2002 was held and Williams was ordered to pay Esoon $90,395.86. Subsequent to the order, Williams was placed into liquidation by special resolution of its shareholders.

Esoon filed a proof of debt with the liquidators for the adjudication award. On the same day, the liquidators declined Esoon's claim on the basis of a set-off. Esoon's debt in the liquidation was entered at $849.25.

Esoon issued proceedings, challenging the liquidators' decision to admit its debt only to the extent of the set-off sum and seeking orders that the liquidator be replaced and awarding indemnity costs against the liquidators.

Partiality

Esoon claimed there was a close association between the shareholders of Williams who appointed the liquidators and the liquidators themselves, and that the Esoon claim had been rejected quickly without proper investigation into the alleged cross-claim by Williams. It was claimed that all of this suggested that the liquidators had not acted impartially. In response the liquidators conceded that no set off should have been allowed and indicated that they intended to resign. The liquidators did not oppose the appointment of Esoon's solicitor as liquidator in their place.

The court, however, considered that the same concerns about partiality would arise if Esoon's solicitor or anyone else with a close association with Esoon was appointed. It is important that any liquidator appointed be seen to have the impartiality required to carry out their duties under the Companies Act. The court, therefore, held that a notice of resignation by the existing liquidators and a consent to act on behalf of a replacement liquidator should be filed. Following this, an order would be made appointing new liquidators. The court stated the newly appointed liquidators should be independent, and if possible, relatively senior, given the need to review the actions of the current liquidators.

Indemnity costs

No order was made for indemnity costs against the liquidators personally. The court was not prepared to make adverse findings as to partiality without first giving the liquidators an opportunity to explain their conduct. However, the judge was satisfied that there was prima facie evidence of partiality. Leave was therefore granted to Esoon to make a formal application for orders in relation to the liquidators' actions. The liquidators would then need to respond fully by stating what they did and why.

Tip for next time

It is inappropriate to appoint a liquidator that has a close association with the appointing party and while this in and of itself does not indicate partiality, it is important that liquidators been seen to be impartial in carrying out their duties.

For further information, please contact your usual Bell Gully adviser or:

AUCKLAND

Brynn Gilbertson
Partner

David McPherson
Partner

Murray Tingey
Partner

Tim Clarke
Senior Associate

Daniel Vizor
Senior Associate

James Caird
Solicitor

Dean Elliott
Solicitor

WELLINGTON

Mike Colson
Partner

Hugh Kettle
Partner

Mark O'Brien
Partner

Brendan Cash
Senior Associate